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Tesco Under Attack From Waitrose In U.K. As U.S. Rollout Imminent Real Estate Key In Both Markets

Jim Prevor’s Perishable Pundit, October 25, 2007

As Tesco prepares to open in the U.S. it is interesting to note what its competitors have to say about Tesco in the United Kingdom. Mark Price, the CEO of upscale rival Waitrose has spoken out clearly urging the U.K. government to restrain Tesco’s marketing power and, particularly, to restrict Tesco’s practice of “land banking” in which it buys up lots and buildings thus effectively precluding others from opening stores. This piece from The Telegraph is headlined Curb Growth of Tesco, Demands Waitrose Boss:

Tesco, the country’s largest supermarket chain, has come under heavy fire with rival Waitrose accusing it of being anti-competitive and of aggressively using its vast wealth to keep rivals out of the market.

Mark Price, Waitrose’s chief executive, said he is calling on the Competition Commission to prevent the UK from becoming “Tescoland”.

The Waitrose boss predicted that unless action was taken the country’s high street grocery industry could, in just 25 years from now, consist of just Tesco and Asda.

Mr Price said he feared the retail environment would be very different in years to come, unless the Competition Commission moved to curb the growth of Tesco.

The commission is expected to report the results of its groceries inquiry later this month.

Tesco is reported to have said that it is confident the commission will determine that there is sufficient choice in the grocery market.

The attack from the Waitrose chief comes only a week after market research analysts CACI revealed that Tesco was the most dominant supermarket in 81 of the UK’s 121 postcode areas.

It was followed by Asda which had the largest market share in 19 postcodes.

Last week Tesco unveiled group sales up 9.2 per cent to £24.7 billion, with pre-tax profits up 18 per cent to £1.29 billion for the half-year to August 15. Mr Price told trade magazine The Grocer that Tesco was against competition and used its vast cash reserves to keep other retailers out of the market.

“They are so aggressive and will buy everything to keep out the competition” he said.

“Waitrose, and all the other retailers, often go head to head with them over property, but they have such deep pockets. It is a challenge because there is so little property out there. Tesco has more in its land-bank than Waitrose has trading space.”

Mr Price said he feared the market could be whittled down to just two major players if something was not done to prevent the march of Tesco.

“In 20 to 25 years’ time, I wouldn’t be surprised if it was just Tesco and Asda in the market. I think the Competition Commission needs to do something to stop this turning into Tescoland. The commission needs to realize what is happening.

“The Government should also be concerned about how vulnerable the country would be if all our food was controlled by one retailer.

“They say customers want choice and are choosing Tesco, but people will go to the store that’s most convenient, so if there is a Tesco on every corner, that’s where they will go.”

Mr Price said Tesco also made lives hard for smaller rivals by using its might to sell products below cost.

A spokesman for Tesco said: “Waitrose should know full well it is a very competitive market out there. More than 94 per cent of the population has access to three or more supermarkets. There is plenty of choice out there.”

Normally we are skeptical whenever competitors ask for government help. But the degree to which Tesco uses real estate as part of a retailing strategy is striking. In fact, we have questioned whether Tesco is actually a great operator at all when you take real estate out of the equation. In a piece we ran back in April entitled A Closer Look At Tesco’s Finances we questioned whether, properly restated to exclude returns on owned real estate, Tesco actually makes much money at all:

Tesco CEO Terry Leahy was reported by Reuters as explaining his position this way:

“Tesco has a lot of property, but it is important to remember property ownership is an integral part of retailing and Tesco will always have a majority of its space as owned space.”

Actually, owning real estate is an excellent way for retailers to report earnings that appear sterling but are actually not providing an adequate return on deployed capital.

In retailing the relevant capital being deployed is not what a building cost 30 years ago or its depreciated basis; it is what the building could be sold for today.

As part of its annual report, Tesco announced that after some large joint ventures that transferred over 10 billion pounds sterling of property to ventures with the British Airways Pension Fund and The British Land Company PLC, Tesco still has real estate, mostly individual stores, worth 28 billion pounds sterling.

Here is the rub: The entire profit of the Tesco organization was just reported, before tax, at 2,653,000,000 pounds sterling. All else being equal, this means that if Tesco sold all the real estate and the new owners leased it back to Tesco on a net, net, net basis (meaning Tesco still had to pay the real estate taxes, insurance, maintenance, etc.) and demanded a 10% return on their investment, Tesco would lose money.

If the investors were content to make a 5% return on their money, Tesco would see its profits plummet by more than 50%. And all this assumes that Tesco’s report on the value of its property is accurate. Possibly, a true liquidation, without regard to lease terms for Tesco, would realize even higher values.

However one figures it, the mighty Tesco has an operating business that crucially depends on billions of dollars in real estate deployed at sub-par returns.

Of course Tesco doesn’t have any real estate in the U.S. and thus has to buy or lease at market terms. This means that even if Tesco were equally successful in operating in the U.S. as it is in Britain, its profits in the U.S. would be dramatically lower.

The truth is that although the FTC has been busy imagining an important anti-competitive issue is the merger of Whole Foods and Wild Oats — in fact like Ahab pursuing the great white whale, they are still trying to undo this now completed merger — the FTC could more usefully devote its time to looking into supermarket real estate disposition.

It is common for supermarkets that have closed stores to refuse to sell, lease or sub-lease the properties without restrictive covenants precluding the sale of food from the property or the use of the property as a supermarket.

In many cases valuable properties sit empty, supermarkets having calculated it cheaper to pay rent on closed space than to allow a competitor to open.

These policies directly limit competition and hit especially hard the ethnic minorities that would be likely to open competitive independent stores.

If the FTC wants to challenge policies in the supermarket industry that restrict retail competition, this would be a good place to start.

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